IMF programs for growing out of debt: Evidence of a catalytic effect on foreign direct investment

Abstract

The financing needs of developing countries are substantial due to repeated crises in recent years. In this global context, policymakers seek financial assistance from the International Monetary Fund (IMF) to address balance of payments issues, despite developing countries' growing reluctance towards IMF loans tied to conditions and fear of adverse market reactions post-IMF agreement. This paper aims to explore whether IMF financial support can attract additional private investment to these countries, by identifying the presence of a catalytic effect of IMF programs between 1985 and 2021. Employing an instrumental variable approach to correct for selection bias, we find that IMF programs have a catalytic effect on foreign direct investment, especially programs involving longer-term IMF engagement conditioned on structural reforms in low- and lower-middle-income countries. Furthermore, we show that IMF programs foster the attraction of greenfield FDI. However, the catalytic effect depends on the economic sector, particularly those characterized by low external financial dependence and high sunk costs. Finally, we highlight that medium-term IMF commitments contribute to reassuring investors regarding macroeconomic stability.